Mortgage Backed Securities, Fannie Mae, Freddie Mac, and more

I am going to describe what a mortgage backed security is by telling you what happens to a mortgage after the loan closing.

Step 1: A homebuyer gets a mortgage through a mortgage company. The mortgage company sells that mortgage to a bank, also known as a loan servicer. (Citimortgage, JPMorgan Chase, US Bank, etc.)

Step 2: The bank sells the loan on the secondary mortgage market. Typically, these loans are bought by Fannie Mae and Freddie Mac.

Step 3: Fannie Mae and Freddie Mac then securitize a group of mortgages and sell them to investors. These securitized mortgages are called mortgage backed securities.

The reason that it works like it does is because individual banks, even very large individual banks, have restrictions on how much money they can lend. By selling these loans on the secondary mortgage market, they free up money to loan to the next person.

Loan servicers like Citimortgage, JPMorgan Chase and Wells Fargo make money on mortgages because Fannie Mae and Freddie Mac pay them a servicing fee. This servicing fee is usually 0.25% of the remaining principal on the loan.

Fannie Mae and Freddie Mac make money when they sell the mortgage backed securities because they pay the investor about 0.5% to 0.75% less than the interest rate they are collecting on a mortgage from the homebuyer.

If you followed all of that, then you understand that the loan servicer (Citimortgage, JPMorgan Chase, Wells Fargo, etc.) gets paid about 0.25% of the interest collected on a home loan. Fannie Mae and Freddie Mac get paid about 0.5% to 0.75% of the interest collected. The rest goes to the owner of the mortgage backed security.